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The "cap and trade" carbon market lurking within former prime minister Tony Abbott's "Direct Action" climate policy will come to life this summer to
meet demand from energy intensive plants that have fallen foul of their emissions caps.

The additional carbon trading activity could nearly double the size of the cottage industry carbon market that currently operates under the Emissions Reduction Fund (ERF) program of the coalition's Direct Action policy, which was established when Mr Abbott was PM.

Under the ERF safeguard mechanism former environment minister Greg Hunt set baselines for the 140 largest industrial emitters of greenhouse gases at historical levels he believed
they would easily meet.

But a handful of facilities – including Alcoa of Australia's Wagerup alumina refinery in Western Australia and South32's Groote Eylandt manganese mine
in the Northern Territory – have exceeded their baselines for 2016-17, the first year of compliance.

"We are seeing the start of the private market for ACCUs (Australian Carbon Credit Units) being established, and the first compliance period will indicate
that a number of large entities will be in the market for credits," said Peter Castellas, chief executive of the Carbon Market Institute, a lobby
for carbon abatement suppliers and energy intensive businesses.

'Cap and trade'

The increased activity and mandatory participation of industrial emitters means the market is starting to look more like the "cap and trade" carbon
market that was designed for the former Labor government by climate policy expert Ross Garnaut a decade ago but abandoned before it could be implemented.

It will test whether Australia's small carbon market will be able to cope with a larger increase in carbon trading under the government's proposed
National Energy Guarantee (NEG) in 2020.
The NEG will come with an emissions "standard" that electricity retailers will have to meet. They can do this either by using emissions-free wind,
solar and hydro energy, or by buying carbon credits from other retailers or surplus ACCUs. These can come from projects such as tree-planting,
fire prevention and savannah clearing to prevent fires, which are mostly funded by the government.

The expansion of the carbon trading industry comes as environment ministers and policymakers, including Australia's Josh Frydenberg, prepare to gather
in Bonn, Germany, for the United Nations climate policy conference. Negotiators will seek to reinforce emissions reduction commitments made in
Paris in 2015 and devise rules for linking national carbon markets.

Mr Castellas said that as the requirement for carbon abatement grows policymakers would need to ensure there are enough ACCUs or other qualifying carbon
credits to meet the additional demand, and the best way to do this was through private markets.

"A good market-based approach to policy will be driven by the private buyer of domestic abatement," Mr Catsellas said. "I think It's going to be a
more efficient way to drive abatement into the future and effectively that puts a carbon price back into the system."

Re-calculate baseline

Entities that are short of ACCUs will need to acquire carbon credits from other facilities with surplus credits or resort to other means allowed under
the ERF legislation – such as calculating a new baseline or averaging their emissions over several years – to square off their liability by the
March deadline.

South32 said it had sufficient ACCUs from an ERF project to cover the liability of the Groote Eylandt mine and Alcoa said it had applied to the Clean
Energy Regulator to calculate a new baseline for Wagerup, which exceeded its 1.4 million tonne baseline by 2.6 per cent or about 36,000 tonnes.
A new baseline may be calculated where a mining or other natural resource project undergoes significant expansion.

About 500,000 tonnes of carbon credits worth about $6 million are already traded each year. Existing demand comes from ERF project operators that have
failed to create the number of ACCUs contracted and need to make up the shortfall. It also comes from businesses seeking ACCUs for voluntary abatement
under corporate social responsibility policies.

Visibility of the shortfall under the safeguard mechanism is limited but carbon traders say about half a dozen to a dozen facilities have blown their
2016-17 baselines by about 200,000 to 300,000 tonnes of carbon equivalent.

That means they will have to buy "ACCU" carbon credits covering 200,000 to 300,000 tonnes of carbon from ERF project operators that have created surplus
ACCUs – unless they can resort to other means allowed under the ERF legislation.

The size of Australia's carbon market is still tiny compared to total annual emissions of about 550 million tonnes and the traders say existing ERF
projects should have enough uncontracted ACCUs to meet the additional demand.